Conventional wisdom says not to put money into savings as a long-term investment. Save for emergencies, but put money into stocks and other securities if you are interested in decent returns. The question is, does the conventional wisdom hold up when you look at the data? Maybe not. At the very least, the data suggests that ISAs can compete with stocks in some cases.
By way of introduction, an ISA is a kind of savings account that allows savers to earn tax-free returns. The two primary types of ISAs are cash ISAs and stocks and shares ISAs. The former is an all-cash account that earns interest the same way any other savings account would. The latter is an account through which the saver's deposits are invested in stocks and shares. Returns are not taxed as either income or capital gains.
Long-Term Performance of Savings
The main criticism of ISAs and savings, in general, is that their long-term performance does not tend to be all that impressive. Savings accounts are less rewarding during times of economic distress – when the government tends to keep the base rate low. Still, interest on savings has been known to climb to relatively high levels. Over a 20-year investment, it is possible to do modestly well with ISAs.
To prove the long-term potential of savings, BBC presenter and financial guru Paul Lewis analysed data from 1995 to 2016, comparing the performance of ISAs with that of a typical FTSE 100 tracker fund. Lewis discovered a number of important things in his data analysis:
- His active cash account beat the tracker fund 57% of the time when comparing rolling five-year increments
- Cash beat the tracker fund 96% of the time when comparing rolling 14-year increments
- His tracker fund lost money up to one-third of the time based on increments between one and 11 years.
It must be noted that Lewis based his research on a couple of important assumptions. First and foremost, that the consumer would seek out the best performing ISA every single year, moving his money into that account. Second, he also assumed compounding interest and/or ISA returns as compared to reinvesting any returns made on stocks.
Over the entire 21-year data period, Lewis' cash account generated 5% compounded while his tracker account produced 6%. So in the end, the tracker account did do slightly better. However, savings did compete very well over the term.
Lessons to Be Learned
Lewis is not the only one to have conducted this kind of research. A number of others have done the same – and reached different conclusions. So why the disagreement? Because investing is not an exact science. Savvy investors with a history of making money do rely on some quantifiable truths that govern the investment world, but they also rely on a certain amount of gut instinct.
It comes down to this: if you put a certain amount of money into an ISA followed by an equal amount of money put into a typical tracker fund, the performance of both would be comparable over a 20-year stretch. But in order for that to happen, investors have to actively engage throughout the term to make sure their money is in the most profitable vehicles. If you simply put your money into one or the other and forget about it, your returns will never be maximised.
This fundamental truth can be combined with Lewis' research to teach us some very important lessons:
- Time Is an Asset – The most important asset any investor has is time. Savings can be very competitive if you are willing to put your money away and patiently wait for a couple of decades. That is the point of investing, isn't it?
- Risk Is Real – Every investor must know what his or her risk aversion is prior to investing. Someone with an exceptionally low-risk tolerance may be very comfortable with ISAs but fearful of stocks. The opposite is also true. This is why experts say investors should diversify.
- Volatility Is Real – The main benefit of ISAs is that they are guaranteed. If you put money into a savings account, it is still going to be there tomorrow, and then the day after, and so on. The same is not true for stocks. Stocks are volatile enough that you could wake up one morning and have nothing. You could also wake up the next morning and have triple the value you started with.
The fact of the matter is that stocks are not the be-all and end-all of investing. They are but one option. Likewise, ISAs can be competitive over extended periods of time and under the right economic conditions too. Don't dismiss ISAs as an option until you've done the research.
- This Is Money – http://www.thisismoney.co.uk/money/diyinvesting/article-3641234/Cash-beats-shares-BBC-s-Paul-Lewis-challenges-conventional-investing-wisdom.html